09-3583-cv

United States Court of Appeals for the

Second Circuit

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

STEVEN BYERS, WEXTRUST CAPITAL, LLC, WEXTRUST EQUITY PARTNERS, LLC, WEXTRUST DEVELOPMENT GROUP, LLC,

WEXTRUST SECURITIES, LLC, AXELA HOSPITALITY, LLC, ELKA SHERESHEVSKY,

Defendants,

JOSEPH SHERESHEVSKY,

Third-Party-Plaintiff,

AVROHOM SHERESHEVSKY, HOLMES REVOCABLE TRUST,

Intervenors-Defendants,

(For Continuation of Caption See Inside Cover) _______________________________

ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK

REPLY BRIEF FOR CLAIMANT-APPELLANT MARTIN MALEK

THOMAS, ALEXANDER

& FORRESTER LLP Attorneys for Claimant-Appellant

Martin Malek 14 27th Avenue Venice, California 90291 (310) 961-2536

TIMOTHY J. COLEMAN,

Receiver-Appellee,

– v. –

MARTIN MALEK,

Claimant-Appellant,

SPACE PARK ISSB PARTNERSHIP,

Interested-Party,

TCF NATIONAL BANK, REGIONS BANK,

Movant-Appellant,

SPACE PARK AIM PARTNERSHIP,

Movant,

AMNON COHEN,

Third-Party-Defendant.

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TABLE OF CONTENTS Page INTRODUCTION ..................................................................................................... 1

UNDISPUTED FACTS ............................................................................................. 5

ARGUMENT ............................................................................................................. 7

I. STANDARD OF REVIEW ................................................................... 7

II. THE DISTRIBUTION ORDER IMPROPERLY INCLUDED COMMODITY POOL FUNDS IN THE RECEIVERSHIP .......................................................................... 8

III. LIQUIDATIONS ARE FOR BANKRUPTCY COURT .................... 11

A. Bankruptcy Courts Are Uniquely Situated to Resolve Liquidations ............................................................ 14

B. The Receiver Failed His Responsibility to Ensure that Liquidations Occur in Bankruptcy Court .......................... 15

C. Appellees’ Cites Do Not Trump the Plain Language in Eberhard and American Board of Trade .............................. 16

IV. THE PRO RATA DISTRIBUTION PLAN IS IMPROPER .............. 18

A. The District Court’s Holding that Any “Commingling” Justifies Pro Rata Distribution Was Legally Erroneous ........... 18

B. The District Court’s Finding of “Commingling” Was Clearly Erroneous ............................................................. 21

C. The District Court’s Standard for “Similarly Situated” Victims Was Legally Erroneous ............................................... 25

CONCLUSION ........................................................................................................ 30

- ii -�

TABLE OF AUTHORITIES Cases Page(s) Bailey v. Proctor,

160 F.2d 78 (1st Cir. 1947) ............................................................................ 17

CFTC v. Eustace, No. 05 Civ. 2973, 2008 WL 471574 (E.D. Pa. Feb. 19, 2008) ..................... 19

Cincinnati Ins. Co. v. Eastern Atlantic Ins. Co., 260 F.3d 742 (7th Cir. 2001) ........................................................................... 9

Dirks v. Clayton Brokerage Co. of St. Louis, 105 F.R.D. 125 (D. Minn. 1985) ..................................................................... 9

Eberhard v. Marcu, 530 F.3d 122 (2d Cir. 2008) ................................................................ 4, 11, 16

Huard v. Shreveport Pirates, Inc., 147 F.3d 406 (5th Cir. 1998) ......................................................................... 20

Lankenau v. Coggeshall & Hicks, 350 F.2d 61 (2d Cir. 1965) ............................................................................ 11

Morrison v. Nat’l Australia Bank, Ltd., 547 F.3d 167 (2d Cir. 2008) ............................................................................ 7

OM Intercontinental v. Geminex Int’l, Inc., No. 03 Civ. 6471, 2006 WL 2707327 (S.D.N.Y. Sept. 18, 2006) ................ 20

Salahuddin v. Goord, 467 F.3d 263 (2d Cir. 2006) ............................................................................ 3

SEC v. American Board of Trade, Inc., 830 F.2d 431 (2d Cir. 1987) ...................................................................passim

SEC v. Better Life Club of America, Inc., 995 F. Supp. 167 (D.D.C. 1998) .................................................................... 20

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SEC v. Black, 163 F.3d 188 (3d Cir. 1998) ................................................................ 3, 10, 24

SEC v. Byers, 637 F. Supp. 2d 166 (S.D.N.Y. 2009) ............................................................. 1

SEC v. Capital Consultants, LLC, 397 F.3d 733 (9th Cir. 2005) ......................................................................... 17

SEC v. Cherif, 933 F.2d 403 (7th Cir. 1991) ....................................................................... 2, 9

SEC v. Credit Bancorp, Ltd., 290 F.3d 80 (2d Cir. 2002) ............................................................................ 17

SEC v. Credit Bancorp, Ltd., No. 99 CIV 11395, 2000 WL 1752979 (S.D.N.Y. Nov. 29, 2000) ........ 17, 29

SEC v. Forex Asset Mgmt. LLC, 242 F.3d 325 (5th Cir. 2001) ......................................................................... 17

SEC v. Lincoln Thrift Ass’n, 577 F.2d 600 (9th Cir. 1978) ................................................................... 14, 17

SEC v. Sunwest Mgmt, Inc., No. 09-6056, 2009 WL 3245879 (D. Or. Oct. 2, 2009) .......................... 19, 24

SEC v. Tipco, Inc., 554 F.2d 710 (5th Cir. 1977) ......................................................................... 17

SEC v. TLC Investments & Trade Co., 147 F. Supp. 2d 1031 (C.D. Cal. 2001) ................................................... 17, 18

Stepniak v. United Materials, No. 03 CV 569A, 2009 WL 3077888 (W.D.N.Y. Sept. 24, 2009) ............... 22

Tibbs v. City of Chicago, 469 F.3d 661 (7th Cir. 2006) ......................................................................... 22

United States v. Ford, 184 F.3d 566 (6th Cir. 1999) ........................................................................... 9

- iv -�

United States v. Ward, 197 F.3d 1076 (11th Cir. 1999) ..................................................................... 20

Webb v. Bunch, 16 F.3d 1223 (6th Cir. 1994) ........................................................................... 9

Statutes 15 U.S.C. § 78u(d) or (e) ............................................................................. 2, 3, 9, 10

Other SEC Brief in SEC v. Capital Consultants, LLC,

No. 03-35406, 2003 WL 22768030 (9th Cir. Oct. 14, 2003) .......................... 8

Appellant Martin Malek respectfully submits this brief in reply on his appeal

of the Distribution Order, see Securities & Exchange Comm’n (“SEC”) v. Byers,

637 F. Supp. 2d 166 (S.D.N.Y. 2009); SPA-1–SPA-41, and states as follows:1

INTRODUCTION

Appellant’s principal contention is that he should not be here.

Where the Real Estate Fund investors were both defrauded and subject to

one of the worst, global real estate crashes in history, the Commodity Pool funds

not only retained value, they made money. Where Real Estate Fund investors were

victimized by “poor timing” in the market and sham real estate deals en route to

spending $250 million on a now-worthless real estate portfolio, the Commodity

Pool Investors’ $17 million investment went exactly where it was supposed to—

investments in highly-regulated commodities markets—and was not defrauded out

of a penny.

In fact, the Commodity Pool Investors were not victims at all until the

Receiver determined, after a costly investigation, that from that $17 million, he and

his firm should take a $12 million fee, and distribute the remaining $5 million on a

pro rata basis among the $17 million of Commodity Pool Investors and the $250

1 Appellant’s opening brief is referred to herein as “Br.”; The Appellee-Receiver’s Brief is referred to as “Opp.” The Appellee-SEC’s Brief is referred to as “SEC Opp.” The remaining capitalized terms have the same meaning as in Appellant’s opening brief.

2

million worth of Real Estate Fund investors. This Plan made Commodity Pool

Investors twice the victim; once, because the Distribution Plan took away virtually

all their money and then sought to return two pennies on the dollar to “victims”

that were not defrauded, suffered no real estate market crash and lost no money,

and again, in larger measure, because more than two-thirds of their assets went to

“administrative” professional costs for a receivership they had nothing to do with.

For these reasons, Appellant’s very first “Issue Presented” was whether the

Commodity Pool funds were improperly included in the Wextrust receivership, see

Br. at 6, and he asked that his (and the other Commodity Pool Investors’) funds be

released since “[n]othing in the statute or case law suggests that 15 U.S.C. §78u(d)

or (e) authorizes a court to freeze the assets of a non-party, one against whom no

wrongdoing is alleged.” SEC v. Cherif, 933 F.2d 403, 413-14 (7th Cir. 1991).

Without explanation, the Receiver ignores the Issue Presented and deletes it

entirely from his brief. Compare Br. at 6 (Issue #1: “Did the District Court err as a

matter of law when it approved a plan of distribution that improperly included

Community Pool assets in the receivership?”) with Opp. at 5 (dividing Issue #3

into two questions and deleting Issue #1).

Moreover, in argument, the Receiver never even addressed whether the

Commodity Pool Investors were wrongdoers, nor whether it had “adduced any

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proof that [Commodity Pool] funds were, or could be deemed, assets of the

defendants, or that the investors themselves were implicated as ‘wrongdoers’ and

thus within the purview of 15 U.S.C. §§ 78u(d) and (e).” SEC v. Black, 163 F.3d

188, 196 (3d Cir. 1998).

For failing to address the issue—and, deleting it from its “Counter Statement

of Issues” altogether—the Receiver has forfeited his right to contest it. See, e.g.,

Salahuddin v. Goord, 467 F.3d 263, 281 (2d Cir. 2006) (“Because the defendants

do not respond to this argument on appeal, they have forfeited for purposes of this

appeal any rebuttal.”).

More fundamentally, the Receiver’s refusal to address the principal issue in

this appeal—whether the Commodity Pool funds belong in the receivership in the

first place—reveal the truth of the undisputed, underlying facts: that the

Receiver’s costly search for “commingling” revealed no theft from the Commodity

Pool funds, no commingling for half of the Commodity Pool funds, and not a

single instance of commingling that affected the Commodity Pool funds during the

time they operated as a highly-regulated, highly transparent investment pool.

These undisputed facts further provide the basis for this Court’s de novo

review of the Distribution Order, and make plain that it should be reversed as a

matter of law for several reasons, namely: (1) the District Court misinterprets the

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requirement of “commingling” and the mere finding of “more than none” is wrong

as a matter of law; and (2) the “victims”—some of whom, like the real estate

investors, were actually defrauded and faced the very real risk of a real estate

market crash, while others, like Appellant, did not—are not “similarly situated” as

a matter of law.

Finally, and as an independent ground requiring reversal, the District Court

erred in liquidating the estate outside of the Bankruptcy Code. See SEC v.

American Board of Trade, Inc., 830 F.2d 431, 436, 438 (2d Cir. 1987); Eberhard v.

Marcu, 530 F.3d 122, 132 (2d Cir. 2008). This Court repeatedly has warned

district courts not to do just what the District Court did in this case, but the

Receiver dismissed these warnings as “dicta” because the Court has not

demonstrated that it meant what it says by reversing.

More disturbingly, although this Court instructed officers of the Court like

the Receiver to tell the District Court it could not liquidate an estate, the Receiver

did just the opposite and urged, inviting error by telling the District Court it was

not bound by “dicta.” See American Board of Trade, 830 F.2d at 438. The Second

Circuit has been right—district courts should not liquidate estates outside the

bankruptcy court. But until this Court reverses on this basis—and this is the case

to do so since real harm occurred—receivers will keep ignoring the directive.

5

For these and the reasons stated below, Appellant asks that the Commodity

Pool funds be released and the Distribution Order reversed.

UNDISPUTED FACTS

Two rounds of briefing confirm that this appeal rests on undisputed facts.

Those facts are:

The only value in the Wextrust receivership is the Commodity Pools. The

Receiver concedes “there was little, if any, going concern value in the Wextrust

real estate operations as a whole.” SPA-6; see also SPA-3 (“The majority of the

cash is in the accounts of the commodity funds.”); JA at A-1578 (“[M]ost of the

cash that’s available is from the commodities funds. Is that true, first of all?

Yes.”). As of the hearing on the Distribution Order, that amount was $15-20

million. SPA-3.

The Wextrust real estate funds are valueless because of a crash in real estate

markets. “[A]s the Receiver pointed out at the Hearing, because of conditions in

the market, ‘the timing of this case could not have been worse.’” SPA-4 n.2. The

Receiver further noted that “[h]ad the fraud been detected sooner, it may have been

possible to recover a greater amount of value for the victims before the real estate

market collapsed.” JA at A-1526; see also JA at A-713 (Sordillo Decl.) (“The

6

majority of the properties owners by the Wextrust Affiliates generate little or no

cash flow.”).

Of the “$15 to 20 million” in the receivership, the Receiver and his firm

expect to be paid more than $12 million. In the first four and a half months of his

receivership, the Receiver and his law firm had billed for and received more than

$6 million dollars in professional fees, JA at A-1883–A-1888; see also JA at A-

1824, and he has budgeted another $6 million in fees for a total of more than $12

million. Id. Moreover, at the hearing on the Distribution Order, he was advised by

professionals that he “need[ed] to retain at least $10 million in the estate as an

equity cushion to provide for the ongoing management of the estate.” JA at A-

1528.

Without seizing the Commodity Pool funds, there would be insufficient

money to pay the Receiver’s fees. The Real Estate Funds, after their crash, had

only approximately $5 million dollars left, with $255 million lost by the Real

Estate Investors. This is less than half of the money charged or budgeted by the

Receiver and his firm. The Commodity Pool funds are “the largest pool of cash in

the receivership estate, and ha[ve] been used to pay administrative expenses of the

estate.” SPA-7; JA at A-993-A-994.

7

The Commodity Pool funds remained part of the receivership because the

District Court found that “any commingling supports a pro rata distribution.”

While the District Court did find as a matter of fact that “there is some evidence

that commingling occurred,” SPA-26, its approval was predicated on a finding, as

a matter of law, that “any commingling is enough to warrant treating all the funds

as tainted.” SPA-24. No actual finding was made regarding the extent of

commingling.

ARGUMENT

I. STANDARD OF REVIEW

The Receiver fundamentally misconstrues the arguments on appeal in

misstating the relevant standards of review. Whether or not “clear error” is the

applicable standard for factual disputes, it is the undisputed facts that reveal the

District Court’s errors at law. Those errors at law are reviewed de novo. Morrison

v. Nat’l Australia Bank, Ltd., 547 F.3d 167, 170 (2d Cir. 2008) (“[W]e review

factual findings for clear error and legal conclusions de novo.”).

For example, although there are factual findings by the District Court

relating to “commingling” and whether victims are “similarly situated,”

Appellant’s quarrel is in large measure the legal significance of those findings—

i.e., whether as a matter of law, “any commingling is enough to warrant treating all

8

funds as tainted.” SPA-24. Appellant’s position is that more than “any”

commingling is required to warrant imposition of a pro rata distribution plan. The

legally improper grounds that any commingling warranted inclusion is reviewed de

novo.

Likewise, as to the District Court’s broad authority to “supervise equity

receiverships,” Opp. at 27-30, and the Receiver’s assertion therefore that a choice

of distribution plan is reviewed for “abuse of discretion,” Opp. at 23, for example,

that is irrelevant to whether the District Court had the authority to approve a plan

of a liquidation on improper legal grounds in the first instance. That is a question

of law, and reviewed de novo.

II. THE DISTRIBUTION ORDER IMPROPERLY INCLUDED COMMODITY POOL FUNDS IN THE RECEIVERSHIP

Appellant’s first issue—whether the Commodity Pool funds belonged in the

receivership in the first instance, see Br. at 6, 22-28—was deleted from Appellee’s

“Counterstatement of the Issues,” see Opp. at 5.

The substantive issues surrounding that question—including (1) the SEC’s

acknowledgement that, “a receiver has no right to property which does not belong

to the entity over which he was appointed, directly or indirectly,” see SEC Brief in

SEC v. Capital Consultants, LLC, No. 03-35406, 2003 WL 22768030, at *15-16

9

(9th Cir. Oct. 14, 2003); (2) consistent case law confirming that the unique species

of “commodity pools” are assets of the investors, not managers, see, e.g., Dirks v.

Clayton Brokerage Co. of St. Louis, 105 F.R.D. 125, 135 (D. Minn. 1985)

(“[P]ools were not assets of the corporations, but were property of individual

investors.”); or (3) the wrongdoer “exception” to Receiver seizures, see Cherif, 933

F.2d at 413-14 (“Nothing in the statute or case law suggests that 15 U.S.C. §78u(d)

or (e) authorizes a court to freeze the assets of a non-party, one against whom no

wrongdoing is alleged.”)—are likewise never addressed.

Appellees’ failure to contest the issue presented constitutes waiver. See,

e.g., United States v. Ford, 184 F.3d 566, 578 n.3 (6th Cir. 1999) (“Even Appellees

waive arguments by failing to brief them.”); Cincinnati Ins. Co. v. Eastern Atlantic

Ins. Co., 260 F.3d 742, 747 (7th Cir. 2001) (“Cincinnati’s argument . . . is not

frivolous or nondispositive, and from Integrity’s failure to mention it, we infer the

Integrity acquiesces.”).

In lieu of responding to the argument, Appellees instead offer a host of

irrelevant and disparate District Court findings relating to whether or not the

Commodity Pool Investors were “similarly situated.” See Opp. at 46-52; cf. Webb

v. Bunch, 16 F.3d 1223, *7 n.2 (6th Cir. 1994) (“Defendant-appellees failed to

respond to this ground of appeal and instead provided the Court with an

10

unnecessary and irrelevant discussion regarding Webb’s character and criminal

history.”).

These arguments, even if related, fail to address the essential issue of

whether the Receiver may retain—let alone distribute—assets that are not properly

part of the receivership estate. As the Third Circuit found in SEC v. Black, 163

F.3d 188 (3d Cir. 1998):

[T]he District Court only determined that . . . the court lacked power over the A, B and D funds. The Trustee’s investigation revealed that the injunction initially imposed pursuant to the freeze order was overly broad … The District Court did this after it was convinced “that the Defendants did not have ‘control’ over funds maintained by Category A, B or D clients. . . so as to permit this Court to freeze the funds pursuant to 15 U.S.C. §§ 78u(d) and (e).” Implicit in the District Court’s ruling was a finding that the Trustee’s investigation had not adduced any proof that Category A, B or D funds were, or could be deemed, assets of the defendants, or that the investors themselves were implicated as “wrongdoers” and thus within the purview of 15 U.S.C. §§ 78u(d) and (e).

Id. at 196.

The Distribution Order should be reversed because the Commodity Pools

should not have been included in the receivership estate. It is not even alleged any

of the Commodity Pool Investors were involved in any of the wrongdoing

perpetrated by the Wextrust Defendants. It is further uncontroverted that WCM,

11

the fraud-free Commodity Pool manager, did not own the Commodity Pool

funds—it was statutorily prevented from doing so—and was not named as a

Wextrust Defendant, and that WCM, Paul Adrian (WCM’s principal) or the

Wextrust Defendants themselves never “wronged” the Commodity Pool funds by

stealing money from them. The Receiver “has no greater rights or powers than the

corporation itself would have,” Eberhard, 530 F.3d at 132, which rights do not

include re-appropriating the Commodity Pool funds to pay administrative costs of

the estate.

III. LIQUIDATIONS ARE FOR BANKRUPTCY COURT

The Receiver likewise challenges, as a matter of procedure, Appellant’s

recitation of consistent Second Circuit law that district courts are not to liquidate

assets in a receivership. See Eberhard, 530 F.3d at 132; American Board of Trade,

830 F.2d at 436, 438; Lankenau v. Coggeshall & Hicks, 350 F.2d 61, 63 (2d Cir.

1965). The Receiver complains that Appellant argues, “for the first time,” that the

Court lacks authority to approve the Distribution Plan, and thereby waives his right

to do so now. Opp. at 4, 30-31.

This is baseless. As the Receiver himself notes, the District Court received

“extensive briefing from over 100 interested parties” and “permitted a lengthy

hearing” at which dozens of parties spoke, including those making this very same

12

argument that the District Court ultimately ruled on. Now, notwithstanding that

the District Court allotted limited time to each of the dozens of persons that made

statements at the hearing and expressly advised against restating arguments already

made, see JA at A-1568 (“I think at least three of the speakers have now addressed

the commodities funds. So I don’t think you need to repeat what was said with

respect to the commodities funds.”), the Receiver insists that Appellant is required

to have re-articulated the arguments, against the District Court’s warning, to

preserve appellate rights. This is not necessary.2

Substantively, in contesting the consistent case law of this Court, the

Receiver repeatedly dismisses it as “dicta,” and instead relies on the “reasoned”

decision of the District Court. The Receiver misses the point. The District Court

itself acknowledged that the “Plan is controversial in many respects—including the

provisions calling for liquidation of the receivership estate.” SPA-2. Indeed, while

ultimately following the lead of the Receiver—“The Receiver has considered a

2 Indeed, the District Court repeatedly admonished speakers he felt took too long or repeated points. See JA at A-1553 (“Let’s finish up, I’ve got several more people.”); JA at A-1555 (“You’re taking too long. Too long. Next, please. Thank you.”); see also Opp. at 32 (“Even before the Wextrust Commodity Investors moved to intervene in the case in December 2008, the district court had already reviewed substantial briefing on those issues in connection with an earlier opinion.”).

13

bankruptcy filing, and believes it would be inequitable”—it nonetheless deemed

“the question a close one that gives me pause.” SPA-19.

At the same time, the District Court conceded that it can only approve a plan

that is “fair and reasonable,” SPA-2, and acknowledged that the decision it relied

on, SEC v. Credit Bancorp, “never directly addressed whether the plan Judge

Sweet addressed ran afoul of dicta cautioning District Courts not to use

receivership proceedings to liquidate estates.” SPA-18 n. 10.

The District Court’s hesitation was warranted and calls for de novo review.

The consistent proclamations of this Court limiting liquidations to bankruptcy,

whether “dicta” or not, require attention and are supported by sound policy.

Moreover, if the Second Circuit’s admonishments are to carry any weight, they

must be enforced where, as here, improper liquidating has resulted in inequity.3

3That inequity extends even beyond the rules the protect creditors in bankruptcy to simple fairness that would prevent approval of distribution plans on false premises. At the hearing to approve the Distribution Plan, the Court asked “[i]f the Court approves the proposed plan, the vast majority of victims will receive at least a partial return of their funds . . . Meaning what? . . . Amount of money? . . .Yes. . . . A nickel or less . . . How much less? . . . It can’t go much below a nickel.” JA at A-1528. In fact it has, in part because the Receiver “has been advised by my accountants and real estate consultants that I need to retain at least $10 million in the estate as a equity cushion to provide for the ongoing management of the estate, so my expectation would be to distribute the excess of that amount that’s available immediately.” Id.

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A. Bankruptcy Courts Are Uniquely Situated to Resolve Liquidations

The Second Circuit has repeatedly warned that liquidations of receiverships

—like the one here—belong in bankruptcy courts, not district courts. There is

good reason for this—bankruptcy courts are uniquely equipped to address the

liquidation of estates. See, e.g., American Board of Trade, 830 F.2d at 437-38;

SEC v. Lincoln Thrift Ass’n, 577 F.2d 600, 605-06 (9th Cir. 1978) (“There are

sound policy reasons for allowing liquidation to take place only in a court of

bankruptcy.”).

Bankruptcy courts have the necessary experience and resources to liquidate

entities. See American Board of Trade, 830 F.2d at 438. In addition, bankruptcies

and bankruptcy courts are bound by the Bankruptcy Code, which sets forth the way

in which liquidations should orderly occur, which regulations are relied on by

investors and creditors. Id.

Bankruptcy court is superior for another reason—one that would have made

a difference in this case. In bankruptcy court, “procedures are better geared for

creditors and depositors to give them a day in court and protect their rights.”

Lincoln Thrift, 577 F.2d at 606. For instance, creditors can form a creditors’

committee, which then elects a trustee to represent its interests. Id. at 605-06.

15

Unlike here, where the Commodity Pool Investors were denied the right to

intervene to protect their assets and were forced to hire numerous counsel and

write ad hoc letters to protect their interests, in bankruptcy court, the Commodity

Pool investors’ rights would have been protected by an entity whose sole purpose

was to represent them.

B. The Receiver Failed His Responsibility to Ensure that Liquidations Occur in Bankruptcy Court

To ensure that liquidations are adjudicated in the proper forum, the Second

Circuit requires the SEC and receivers to advise the District Court that it should

not embark on a liquidation of the receivership estate. See American Board of

Trade, 830 F.2d at 438 (“[W]e expect counsel for the agency, as an officer of the

court and as part of his or her individual professional responsibility, to bring our

views, as stated in this and other decisions, to the attention of the district court

before the court embarks on a liquidation through an equity receivership.”).

The Receiver claims that he “informed the district court early” about the

Second Circuit’s repeated admonitions that cases such as this one belong in

bankruptcy court, Opp. at 31, but the opposite is true, even in the instances he

himself cites. At A-1321, for example, he argued that this case is not a liquidation

and therefore does not belong in bankruptcy court. Likewise, at A-1402 and Dkt.

16

82 at 23, he baldly dismissed the Second Circuit’s admonitions as “dicta,” and

affirmatively argued—contrary to clear Second Circuit law—that a receiver “has

the right to choose the forum in which he or she proceeds with liquidation.” Opp.

at 31-32; A-1321, A-1402, Dkt. No. 82 at 23.

In short, the Receiver did not just fail to advise the District Court—as

required to by the Second Circuit—that this case belonged in bankruptcy court.

See American Board of Trade, 830 F.2d at 438. He consistently did the opposite.

The Receiver should not be rewarded for this failure.

C. Appellees’ Cites Do Not Trump the Plain Language in Eberhard and American Board of Trade

The SEC’s and the Receiver’s arguments do not change the meaning of

Eberhard and American Board of Trade.

The Receiver first attempts to confuse the issues before this Court by

equating the sale of specific real estate assets of the receivership estate with

liquidating the estate as a whole. Opp. at 32-33; see also SEC Opp. at 5

(acknowledging the difference). No one is objecting to the Court’s—and the

Receiver’s—ability to sell off various discrete assets of the receivership estate.

Opp. at 33 (citing Dkt. Nos. 160-61, 198-200, 202, 219, 244-46, 300-01, 399, 427,

54-142—all of which involved the sale of specific assets of the receivership

17

estate). Malek’s “failure” to object to such requests has nothing to do with the

issues here on appeal.

The SEC argues that “it is well-established that a district court has the

discretion to approve a distribution plan . . . that liquidates the assets of the

receivership and distributes them on an equitable basis to investors and creditors.”

SEC Opp. at 5-6. For this statement—which is proven false by the Second

Circuit’s repeated admonitions to the contrary, the SEC cites only one Second

Circuit case—and that case acknowledges the Second Circuit’s admonition in

American Board of Trade. See SEC v. Credit Bancorp, Ltd., 290 F.3d 80 (2d Cir.

2002); SEC v. Credit Bancorp, Ltd., No. 99 CIV 11395, 2000 WL 1752979, at *27

(S.D.N.Y. Nov. 29, 2000). In the other cases relied upon by the SEC, whether the

case belonged in bankruptcy court or district court was not at issue.4 See SEC v.

Capital Consultants, LLC, 397 F.3d 733 (9th Cir. 2005); SEC v. Forex Asset Mgmt.

LLC, 242 F.3d 325 (5th Cir. 2001); SEC v. Tipco, Inc., 554 F.2d 710 (5th Cir.

1977); Bailey v. Proctor, 160 F.2d 78 (1st Cir. 1947).

Finally, the Receiver relies heavily on SEC v. TLC Investments & Trade Co.,

147 F. Supp. 2d 1031 (C.D. Cal. 2001). See Opp. at 35-37. In TLC, the court

4 The one exception to that is Lincoln Thrift, 577 F.2d 600, which, as discussed above, details why these cases belong in bankruptcy court.

18

acknowledged that “it is only in rare cases that it is appropriate for a receiver,

rather than a bankruptcy court . . . to liquidate” and then found that case to be one

of the “rare cases” because “there [was] such a close connection between the

actions necessary for ongoing oversight of the receivership’s assets and for

liquidation of those assets.” TLC, 147 F. Supp. 2d at 1036. The Receiver has

demonstrated no such connection here. Regardless, this is not Second Circuit law.

IV. THE PRO RATA DISTRIBUTION PLAN IS IMPROPER

The pro rata distribution contemplated by the Distribution Order is improper

as a matter of law. The Receiver concedes that “pro rata” distribution plans are

appropriate only when (1) funds are “commingled” and (2) victims are “similarly

situated.” Opp. at 39; see also SPA-23 (“[T]wo factors must be satisfied to

approve a pro rata distribution.”). The Distribution Plan, as a matter of law

(reviewed de novo) and record facts (reviewed for “clear error”), satisfies neither

condition.

A. The District Court’s Holding that Any “Commingling” Justifies Pro Rata Distribution Was Legally Erroneous

Although the Receiver argued, as he does on appeal, that commingling was

“pervasive,” the District Court did not find as much: “[T]here is some evidence

that commingling occurred, and the law does not appear to require more than that.”

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SPA-26. Instead, as the basis of its opinion, the District Court held that “any

commingling is enough to warrant treating all the funds as tainted.” SPA-24

(emphasis in original). This is unsupported in law and sense.

No case holds that “any” commingling justifies a pro rata distribution. The

District Court observed that in the case of federal receiverships, “only one decision

. . . addressed the extent of commingling” required, SPA-25, and even then only to

say that it need “not necessarily [be] systematic.” Id. (citing CFTC v. Eustace, No.

05 Civ. 2973, 2008 WL 471574, at *7 (E.D. Pa. Feb. 15, 2008). The Receiver was

no more successful in finding any such rule, citing only Eustace and the District

Court in support. Opp. at 45.5

In practice, however, whether systematic or not, the commingling sufficient

to warrant pro rata distribution is routinely found to be “extensive,” “pervasive”

and sufficient to render “indistinguishable” the sources of funds. See, e.g., SEC v.

Sunwest Mgmt, Inc., No. 09-6056, 2009 WL 3245879, at *6 (D. Or. Oct. 2, 2009)

(“[T]here was extensive and wrongful commingling of funds” and the “pervasive

nature of the commingling has rendered it virtually impossible to trace.”); United

5 The Receiver cites a host of cases in support of the District Court’s “broad discretion” where some funds are “tainted.” See Opp. at 44-45. Those cases do not address the extent of commingling required to warrant pro rata distribution which, the District Court observed, has been directly addressed infrequently.

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States v. Ward, 197 F.3d 1076, 1083 (11th Cir. 1999); SEC v. Better Life Club of

America, Inc., 995 F. Supp. 167, 180-81 (D.D.C. 1998).

Moreover, in analogous examination of commingling in other contexts,

courts have found the opposite: that it is not “commingling” if only occasional,

unsystematic or immaterial intra-transfers of funds occur. For example, plaintiffs

seeking to “pierce the corporate veil” between entities often refer to commingling

of funds as evidence of a unified organization. In that context, courts observe that

the fact “that [a principal] occasionally borrowed money from Geminex but always

repaid the debt before the close of the year does not qualify as intermingling of

corporate and personal funds, nor does it show siphoning of funds.” OM

Intercontinental v. Geminex Int’l, Inc., No. 03 Civ. 6471, 2006 WL 2707327, at *8

(S.D.N.Y. Sept. 18, 2006); see also Huard v. Shreveport Pirates, Inc., 147 F.3d

406, 413 (5th Cir. 1998) (“[V]arious transfers of funds between two corporations

and between the shareholder and the two corporations . . . do not demonstrate a

commingling of corporate funds with the funds of the individual, thereby

destroying the separate identities of the entities.”).

As a matter of policy, the circumstance here is identical. Just as

corporations are fairly judged to be unified entities where commingling is

pervasive or extensive—and thus responsible for each others’ debts—so too is an

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equal, pro rata distribution sensible where assets of multiple entities are entirely

fungible and a common manager has treated them as such. However, a flat rule

that “any” commingling warrants redistribution of assets evenly among victims of

extensive and pervasive fraud on the one hand, and “victims” of even a single

instance of an unauthorized funds transfer, defies sense: the entities are unlike, and

a single instance of “commingling,” even if proved, does not change that.

In short, there was no finding on commingling, just an assumption that “any”

was enough. That assumption is incorrect and, accordingly, pro rata distribution is

unwarranted and the Distribution Order must be reversed.

B. The District Court’s Finding of “Commingling” Was Clearly Erroneous

The District Court’s erroneous legal invention was compounded by a clearly

erroneous, albeit implied, factual “finding.” In contrast to the real estate and

diamond mine investments, as to which the District Court explicitly found “there

was extensive commingling,” SPA-25–SPA-26,6 the District Court relied on

absent, improper and misinterpreted evidence to conclude that the “evidence of

6As relevant here, the District “Court considers the diamond mine investments as part of the Real Estate Fund investments, on the ground that investments in the diamond mines were made on the same terms as investments in the Real Estate Funds, and there was as much commingling of the funds raised for the diamond mine investments as the Real Estate Funds investments.” SPA-25.

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commingling is sufficient” to warrant a pro rata distribution. That “finding” was

clearly erroneous for several reasons.

First, as to two of the four Commodity Pools, it is uncontested that there is

no evidence of any commingling, and the Receiver and the District Court were

simply willing to assume none for purposes of the Distribution Order. See JA at

A-1535 (“I’m prepared to assume, for purposes of the argument, that for this

particular futures fund, there was no commingling.”); id. (“I think the receiver

would argue, even assuming it’s true that for this particular fund there was no

commingling, when you look at the big picture, it should be included anyway.”);

id. at A-1536 (“Even assuming that there was no commingling . . . we, I think,

have established enough commingling occurred in general with respect to those

WexTrust commodity funds.”). Assumptions are not evidence and these funds

clearly were not commingled.

Second, as to the remaining two funds, the District Court relied first and

principally (and the Receiver continued to rely) on allegations of a National

Futures Association complaint. Those allegations are not evidence as a matter of

law, see Stepniak v. United Materials, LLC, No. 03-CV-569A, 2009 WL 3077888,

at *5 (W.D.N.Y. Sept. 24, 2009) (“[A]llegations in a complaint are not evidence.”);

Tibbs v. City of Chicago, 469 F.3d 661, 663 n.2 (7th Cir. 2006) (“[M]ere

23

allegations of a complaint are not evidence”), and the complaint acknowledges as

much by offering the opportunity to “respond to each allegation by admitting [or]

denying” them. See JA at A-1511.

Moreover, the bulk of the allegations do not even concern commingling, but

“deceptive and misleading” monthly newsletters, id. at A-1508, failure to disclose

clearing brokers, id. at A-1507, failure to designate funds within two weeks, id. at

A-1506, or failure to disclose potential conflicts of interest, id. at A-1508. The

lone page of the Complaint that concerns alleged “commingling” between a

Wextrust entity and the Commodity Pools alleges three transfers, each of which

was allegedly made before the Commodity Pools were even operational.7 See JA

at A-1504 at ¶¶ 18-20. The Receiver’s bastardizing of these alleged “facts” into

commingling is precisely why allegations do not constitute evidence.

Third, the evidence of transfers actually before the District Court was not of

“commingling.” While the Receiver admits that “the work Deloitte did was not

comprehensive,” JA at A-1536, and required a finding of commingling if Deloitte

was to be paid out of the Receivership, it does not acknowledge that Deloitte’s

7 The Receiver concedes that the funds for the Commodity Pools were not released for their establishment until September 3, 2007, well after the three instances of alleged “commingling” even occurred. Opp. at 8.

24

evidence consisted almost exclusively of transfers into the Commodity Pools that

were actually distributions and reinvestments.

For example, the lone instance cited by the District Court refers to a victim,

Mr. Costa, who asked that his money be transferred from a real estate fund to a

Commodity Pool fund. See SPA-27–SPA-28. In accordance with that request,

Wextrust “paid” him money from some other fund—a distribution, not

commingling—that was then reinvested. Just as the Receiver is not aggregating

funds that were distributed prior to discovery of the fraud, it is not entitled to

selectively recharacterize distributions and re-investments that investors were

aware of as “commingling.” See Sunwest, 2009 WL 3245879, at *6 (identifying

commingling “without the knowledge or consent of affected investors and

creditors”); Black, 163 F.3d at 197 (“Although the Trustee’s report discussed the

existence of evidence showing commingling and transfers between the pooled and

non-pooled accounts, there is no evidence this was done by anyone other than

defendants.”).8

8 In fact, the “frequent misappropriat[ion of] money from non-commodity victims,” Opp. at 12, on which the Receiver dwells likely occurred every time a Real Estate Investor took a distribution. However, this “misappropriation” is not, and is not maintained to be by the Receiver, an opportunity for the Receiver to go and reclaim those distributions.

25

In short, the three instances of money transferred out of the Commodity

Pools, ignoring for the moment that the Commodity Pools were not even operating

yet, compelled the Receiver to concede “on an overall basis the amount of

commingling between and among the commodity funds was probably less than

what occurred in some other investment vehicles.” JA at A-1580. That amount

was nil, and cannot support a pro rata distribution as a matter of fact.

C. The District Court’s Standard for “Similarly Situated” Victims Was Legally Erroneous

The District Court’s finding that Real Estate Fund investors were “similarly

situated” to Commodity Pool Investors is similarly without basis, factually or

legally.

Contrary to the Receiver’s claim that the court “found that all of the

Wextrust investors were similarly situated based on five reasons, Opp. at 46-47,

the District Court actually held that these five reasons only support the conclusion

“that the Real Estate Investors were similarly situated.” SPA-29–SPA-30; see also

id. (“I agree that the circumstances under which the Real Estate Funds investors

made their investments was sufficiently close to satisfy this requirement.”). The

Receiver simply, and deceptively, misstates the finding.

26

In contrast, the District Court lists no factors that suggest an identity of

circumstances between the Real Estate Fund investors and the Commodity Pool

Investors and instead, while acknowledging the need for “a reasonably close

resemblance of facts and circumstances,” SPA-29 , relied on precisely the same

three money transfers discussed supra to conclude that Wextrust entities had

control over the all funds and the Receiver had authority to seize them. SPA-30–

SPA-33. While Appellant rejects both contentions, they are ultimately irrelevant

since the Commodity Pool Investors were not “similarly situated” to the Real

Estate Fund investors as a matter of law.

As a matter of law, and as stated in Appellant’s opening brief, investors are

“similarly situated” where the investments share a “reasonably close resemblance

of facts and circumstances,” including common levels of risk and reward, similar

relationships to the defendant, and a common fate. See Br. at 35-44 (citing cases).

In lieu of addressing these factors, the Receiver claims simply and without

the benefit of legal authority that “equity jurisprudence clearly accords the district

court discretion to approve a pro rata distribution independent of any consideration

of ‘level of risk, timing of investment, tracing analysis or some other factor.’”

Opp. at 51 (emphasis added). It does not, and even cursory examination of the

relevant factors makes plain that these investors were not similarly situated.

27

As to risk level, for example, the parties agree that Real Estate Fund

investments are fundamentally different from commodity pool investments. The

Commodity Pool Investors chose highly regulated Commodity Pools investing in

commodities such as energy and metals, where Real Estate Investors invested in

highly speculative real estate projects including hotels, diamond mines and multi-

use office buildings subject to the “substantial negative effect” of competitive

forces in real estate.9

The expectations of what risk their respective investments were subject to is

plain from Appellant’s own testimony at the hearing to confirm the Distribution

Plan: “Real estate investors might be disappointed while commodity investors are

in shock that they would be affected by the sinking real estate market.” JA at A-

1565. Moreover, those risks were realized, as both parties acknowledge. Where

the Real Estate Funds lost significant value due to market risk, see JA at A-1452

(noting that the real estate was purchased at “the height of the commercial real

9 The Receiver’s quixotic response to this dissimilar risk level is merely to suggest that “the fact that the Wextrust Commodity Pools sold securities for the purported purpose of speculating in commodities (as opposed to real estate or diamond mining) does not affect the district court’s discretion to include them in the receivership estate.” Opp. at 48. Although it does, see Br. at 22-28, that is irrelevant to the examination of whether commodities investors are “similarly situated” to defrauded real estate investors that are victimized by a worldwide real estate market crash—a risk they accepted in investing in real estate.

28

estate boom, and the fair market value of these properties had fallen

substantially”); JA at A-1720 (noting that the values of the real estate properties

had “fallen substantially … primarily as a result of the collapse of the United

States real estate market.”), the Commodity Pools were unaffected by the real

estate crash and lost none of their value. See JA at A-828 n.7, A-1071, A-1340.

Likewise, as to “relationship to the defendants,” the respective funds were

treated differently by those defendants—the Wextrust principals committed fraud

in the Real Estate Funds by failing to purchase the subject real estate. Thus, “[i]n

some instances, the perpetrators of the scheme actually did use investor money to

buy specific pieces of property, but in many instances they did not.” SPA-4.

Likewise, $40 million raised for diamond mine real property rights in South Africa

disappeared and has not been accounted for. SPA-8. Accordingly, “[t]he reason

the Wextrust entities are in shambles . . . is fraud. The principals of the Wextrust

entities are accused of effectively looting the business for their own personal gain.”

SPA-19.

In contrast, the Commodity Pools were not looted. When they were

liquidated, they left “a substantial amount of cash.” SPA-7. In contrast to the Real

Estate Funds, the Commodity Pools were found that have “made real trades with

real assets.” Id. The assets of the Commodity Pools were used for their intended

29

purpose—to serve as margin for commodities trading. JA at A-1069–A-1071, A-

1340. Whatever “massive Ponzi scheme” there was, it did not result in the highly-

regulated Commodity Pools losing a dime, nor even having any material amount of

money unlawfully removed, at any time it was actually operating.10

Finally, and in part owing to the first two factors, the different funds shared

no “common fate.” “The majority of the properties were purchased between 2004

and 2007—prior to the crash of the real estate market.” Op. at 4. Owing to this

crash, the majority of the real estate assets are worthless, being variously “in

default,” having a “market value less than the secured debt,” or else having “little

or no equity due to economic conditions.” Op. at 5. Accordingly, the Receiver

10 As to whether the Real Estate Investors and Commodity Pool Investors were “similarly situated” as to their treatment by the Wextrust Defendants, the Receiver again refuses analysis, instead citing SEC v. Credit Bancorp, No. 99-cv-11395, 2000 U.S. Dist. LEXIS 17171, *61 (S.D.N.Y. Nov. 29, 2000) for the proposition that “Malek and the remaining Wextrust Commodity Investors would prefer to have their claims considered in isolation from the remaining Wextrust investors.” Opp. at 49. This is correct although again, irrelevant to the examination of whether that isolation is warranted because the investors are not “similarly situated.” Moreover, and with respect to Credit Bancorp, while the Receiver himself identifies its notation that “equitable concerns may supercede” other ownership rights, Opp. at 50, he does not address those “equitable concerns” here: that no money was stolen, that the investor-types were exposed to fundamentally different risks, and that the result—real estate investors were unfortunately victimized by a crash in real estate markets and commodity pool investors were not—was not similar.

30

himself determined that “there is little, if any, going concern value in the Wextrust

real estate operations as a whole.” Op. at 6. In contrast, the Commodity Pools –

before the Receiver began to pay himself with them—contained full value, never

having lost a dime.

In short, the undisputed facts reveal no “reasonably close resemblance of

facts and circumstances,” but instead the opposite—widely disparate investments

whose ultimate ends were different.

CONCLUSION

For all the foregoing reasons, the Court should reverse the District Court’s

Order of July 23, 2009 approving the Distribution Plan, and remand this cause to

the District Court for release of the Commodity Pool assets to the Commodity Pool

Investors.

Dated: January 29, 2010 Respectfully submitted,

THOMAS ALEXANDER & FORRESTER LLP

By: Emily Alexander 14 27th Avenue Venice, California 90291 Telephone: (310) 961-2536 Facsimile: (310) 526-6852

Attorney for Appellant Martin Malek

31

CERTIFICATE OF COMPLIANCE WITH RULE 32(a)

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32(a)(7)B) because:

This brief contains 6,878 words, excluding the parts of the brief exempted

by Fed. R. App. P. 32(a)(7)(B)(iii).

Counsel for Appellant

Dated: January 29, 2010

ANTI-VIRUS CERTIFICATION FORM Pursuant to Second Circuit Local Rule 32(a)(1)(E)

CASE NAME: Securities and Exchange Commission v. Byers DOCKET NUMBER: 09-3583-cv I, Natasha S. Johnson, certify that I have scanned for viruses the PDF

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________________________________ Natasha S. Johnson Date: January 29, 2010

STATE OF NEW YORK COUNTY OF NEW YORK

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On January 29, 2010 deponent served the within: Reply Brief for Claimant-Appellant Martin Malek

upon: JOHN WARREN DEWEY & LEBOEUF LLP 1101 New York Avenue, NW Washington, D.C. 20005-4213 jwarren@DeweyLeBoeuf.com Attorneys for Receiver-Appellee

Timothy J. Coleman

DAVID LISITZA U.S. SECURITIES AND EXCHANGE COMMISSION 100 F Street NE Washington, DC 20548 lisitzad@sec.gov

the address(es) designated by said attorney(s) for that purpose by depositing 2 true copy(ies) of same, enclosed in a postpaid properly addressed wrapper in a Post Office Official Overnight Express Mail Depository, under the exclusive custody and care of the United States Postal Service, within the State of New York and electronically by email. Sworn to before me on January 29, 2010

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